Inventory Turnover Rate is very simply your company sales (in terms of
the cost to the company) divided by the average cost of the carried
inventory. This number is a broadly used method of determining how
efficient an organization is at inventory management.

I. Leveraging Inventory Turnover Rate

The reasons to use inventory turnover rate as an efficiency benchmark
is simple: product costs capital, both directly and indirectly. The
direct costs are the price of inventory and the order processing fees,
including shipping costs.

The indirect costs include handling labor from receipt
through shipment, the rental cost of storage space, the capital
investment in storage systems such as racking and material handling
equipment, and taxes on both property and, in some regions, on the
inventory value itself.

An inventory turnover rate of one or greater is
generally carried by current year capital expenses. Anything under one
generally is leveraged inventory, which can greatly increase the
carrying cost of inventory for the company. Over-leveraged companies
tend not to handle the rigors of economic uncertainty, so this inventory
metric is used by investors as well.

Revenue comes from sale of in-stock product and not drop-ship inventory or expedited order stock.

Inventory turnover rate can be calculated at virtually
any interval. Some organizations only calculate it annually, while
others will do a valuation twice monthly because inventory levels vary
so widely over time.

The key is to select a date or day of the month and consistently use
that date. Most organizations choose the first or the fifteenth of
every month. By averaging these monthly values, accurate inventory
valuation is attainable.

It is critical to pick one type of inventory cost: average cost, last
cost or replacement cost to ensure consistent valuation of the
inventory. Setting your goal for inventory turns depends on the gross
margins in your industry.

For high-margin stock, one turn annually may be
adequate to successful business operations. In industries with a more
standard 20-30% margin, most organizations strive for 5-6 inventory
turns annually. Using inventory turnover in a predictive fashion can
help you leverage your revenue as operating capital instead of borrowing
to support & manage inventory.

II. Calculating Inventory Turn

An inventory turn can be calculated for any
period pertinent to your business. The most commonly used time periods
are a month or a year, but sometimes a single inventory turn may be
defined in a number of days for fast-moving inventory.

Another set of costs associated with cost of goods are waste and
shrinkage. Depending on the industry, these two factors can
significantly impact these calculations. In manufacturing environments,
flawed final products or scrap produced represent a material loss to the
overall value of product sold.

The tricky part is that scrap and shrinkage from theft or sales
incentives are sometimes difficult to track. It is critical to have
processes in place to record values and then include them in the
inventory turns calculation. Instead of the standard:

By including that proper COGS valuation in the formula for
calculating your inventory turn rate, there is more operational analysis
credibility to the result of:

Inventory turn rate = COGS / Cost of average inventory level

Once accurately determined for the whole inventory, it is
critical to identify where the areas of opportunity are in your
inventory population. Inventory turn rate can be artificially elevated
or deflated by certain inventory items. A high cost, high margin item
may conceal the presence of many slow-moving items.

Top 100 and Bottom 100 items can both carry significant impact of
the frequency of an inventory turn. Digging into the details of
inventory turns can be the critical analysis necessary to take your inventory management to the next level of efficiency.

Top 100 and Bottom 100 items can be viewed from a number of different measures. These can be calculated in terms of:

number of units sold;

number of orders containing those units; or

total dollars sold.

By actively managing the Top and Bottom 100 items, this can
impact you rate the most significantly with the least amount of
analysis.

III. Improving Inventory Turnover

In a perfect company, inventory turnover
approaches an infinite number because nothing sits on the shelves,
ever. In a real but lean inventory management environment, inventory
turnover is balanced with other inventory control factors such as Economic Order Quantity and Safety Stock calculations to protect both profitability and customer service.

Balancing inventory turnover starts with accurate demand
forecasting. Actively engaging customers in predicting their future
demands, particularly in a business to business supplier environment can
help determine the optimum stocking levels versus supplier lead time
and ordering costs.

If customers cannot or will not provide this data, then
historical data can provide a starting point for stock turnover trends.
Using historical data cannot be a blind process. Experienced analysts
must view it in terms of trends and also consider the impact of new
products coming to market.

Because they lack a history, new products are generally the most
difficult ones to predict demand. Having accurately collected data on
similar product performance in various economic times can mitigate the
unknowns in new product demand forecasting. It is critical to have a
plan in place to either address demand spikes or overstocks with new
products.